Thursday, January 19, 2017

Ben Bernanke's Article on the Fed, and General Infrastructure Talk

So today I'm going to break down Ben Bernanke's dry but very informative article on the Fed's reaction to the incoming Trump administration's plans.  It goes without saying I encourage you to read the article and draw your own conclusions.  That said, here are mine!  (Emphases added throughout is all mine.)

First of all, while the market has responded very positively to Trump's election, the Fed isn't necessarily buying it.  Given that "the market" as a whole tends to be irrational, this is not a big surprise.  

Here's what the market is seeing:

While it’s hard to know how much of the market’s optimism reflects expected policy changes under the new administration, the rise in equities, interest rates, and the dollar since the election is precisely the configuration that standard macroeconomics would predict in anticipation of a Trump-backed fiscal expansion. (A similar pattern occurred in the early Reagan years, which was dominated by tax cuts, increased military spending, higher deficits, and rate increases by the Federal Reserve.)

Here's what the Fed is seeing:

Notably, at the median, expected real growth was raised by only 0.1 percent for 2017, relative to the September projection, and no change was made for expected growth in 2018. No change at all was made to the median inflation projections for 2017 or 2018. The median path for the Fed’s policy interest rate included just one additional rate increase over the next two years—a small adjustment, probably reflecting changes by only a few participants.

But why?

For assessing the effects of a fiscal program on near-term growth, the details—few of which are currently available—matter a lot. According to the minutes, FOMC participants in the December meeting expressed considerable uncertainty about the “timing, size, and composition” of a prospective fiscal package. But I suspect that in thinking through possible fiscal scenarios, Fed policymakers saw many as suggesting a fiscal program with less near-term economic impact than markets appear to be assuming.

This in part reflects some uncertainty that a GOP-led Congress will want to foot a large infrastructure bill, given the GOP's adherence to "fiscal conservatism".  I personally have a lot of skepticism that the GOP Congress will stand up for their collective beliefs against the word of their President.  GOP fiscal conservatism didn't stop Reagan from spending big and running up a huge deficit, and I don't expect GOP fiscal conservatism will stop Trump from doing the same.  But for the Fed things it's enough of a possibility that there's reason for caution.

A more substantive Fed concern is this:

Alternatively, if Congress opts to reduce the deficit impact of an infrastructure program by financing it through tax credits and public-private partnerships, as candidate Trump proposed, the program might turn out to be relatively small. 

Indeed.  I'll go into this in much greater detail below, but let's just say there is a lot of reason to be skeptical of public-private partnerships, also known as P3s.

Tax-wise, personal tax cuts are expected to be a large part of the program.  Historically, personal tax cuts, especially for high-income households, have proven to be largely ineffective at driving economic growth (even though very creative arguments continue to circulate in their favor):

Based on what we’ve heard both from Trump and from congressional Republicans, personal tax cuts, especially for higher-income households, are likely to be a big part of the program, and probably the easiest part on which to reach agreement. However, whatever the longer-term benefits of tax reform, high-income consumers may save much of any tax cut they receive, implying that the effects on demand of such cuts are likely to be smaller than the effects of direct government spending.

There's also the issue of timing.  Infrastructure programs can take years to build, so expecting skyrocket growth right off the bat is not necessarily realistic.  Here's a good, short article on the "shovel-readiness" of the top 10 infrastructure plans currently in the planning stage.  (It is worth noting, from this article, that Barclays bank shares many of Bernanke's notes of caution regarding Trump's overall infrastructure plan.)

The Fed sees the danger of possible contradictions within Trump's overall plan.  Perhaps his infrastructure program will be good for economic growth, but perhaps his protectionist agenda will prove a drag on that very growth.

And let's never forget that a "stronger" dollar, as reassuring as the word "strong" may be, generally throws a damper on things:

Financial markets are forward-looking, and, as I’ve discussed, asset prices have already built in expectations of a strongly expansionary fiscal stance in the next few years. However, the changes in asset prices themselves may partially offset the effects of the eventual fiscal program on economic growth. For example, all else equal, the increase in longer-term interest rates since the election may reduce investment spending, including home construction, and the stronger dollar could prove a headwind for exports. (On the other hand, higher equity prices would tend to support higher rates of consumer and business spending.) In the Fed staff forecasts for the December meeting, according to the minutes, the positive effects of assumed fiscal changes on growth and inflation were “substantially counterbalanced” by the restraining effects of higher longer-term interest rates and the stronger dollar.

As noted above, perhaps economic headwinds will be offset by higher equity prices.  As a worker and consumer, I certainly hope they do!

So that's my take on Ben Bernanke's article.  Paul Krugman believes that little to no real investment is coming, for what his opinion is worth.  I am inclined to agree with that position, and to tell you why, we need to discuss P3s.

P3s are all the craze at the state level these days, and that's no surprise.  For nearly forty years now, we've had government either by a party that believes that "government is the problem" or another party that won't go that far, but believes "the era of big government is over".  Therefore a P3, in which a private investor takes on much of the risk and spending for a public infrastructure project, is right up everyone's ideological alley.

It also presents a short-term political benefit in that financial burdens undertaken by a private investor do not show up on the balance sheet of a state of local government.  So any ol' Mayor or Governor can get a big infrastructure project going and say to the voters, "Look, I didn't spend a dime!"

There's, of course, a few big problems with this approach:

Turning to private investors to finance public works isn’t free money. Investors expect to be paid back and earn a profit on their investment.

“In the highway community,” said Jones of the IBTTA, “private investment means toll roads.”
Tolls often enable investors to generate revenue and keep projects as close to revenue-neutral as possible.

But critics point out the perils of P3s relying too heavily on tolls and other user fees to generate revenue. Many private investors, for example, push for noncompete clauses that limit or ban the development and maintenance of surrounding projects.

The noncompete clauses are designed to assuage investors who fear the construction of similar public projects might cut into their revenue. But Kevin DeGood, director of infrastructure policy at the left-leaning Center for American Progress think tank, said they can tie the hands of public officials who may want to construct something for the common good.

Yes.  Freedom ain't free, kiddos.  If you want to keep your pesky socialism out of your dang highways, you're going to end up handing responsibility for public roads over to folks whose sole concern is to make a buck.  Private investors care about making money.  They do not care about the public good except insofar as those two interests might intersect, which they frequently do not:

And P3s may not work everywhere. For example, investors may ignore projects planned for less-populated areas if traffic on their roadways would not generate enough toll revenue.

“If I was a private toll road operator,” Jones acknowledged, “I don’t think I’d want to build a toll road in North Dakota or Wyoming, because I’m not likely to get a return on my investment.”

P3s may come up short in the revenue department, and when that happens, unlucky civilians may pay the price.  Just read this whole mess about the Capital Beltway HOT (High-Occupancy Toll) Lane Project.  What a mess:

In 2007, a private consortium reached a deal with the state of Virginia to construct HOT lanes on a 14-mile stretch of the Capital Beltway, long considered one of the most congested highways in the nation. The project increased the number of lanes on the highway and charged tolls in HOV lanes based on the level of traffic congestion.

In exchange for financing more than two-thirds of the $1.4 billion project, the private partners would collect toll revenue for the next 80 years. Construction was completed in late 2012, slightly ahead of schedule, but traffic in the HOT lanes was initially lower than projected. As a result, Transurban, the company responsible for processing tolls and violations, faced a deficit totaling hundreds of millions of dollars.

Following the lower-than-expected revenue, Transurban began charging excessive penalties for motorists who failed to pay toll fees, which resulted in a class-action lawsuit against the company.
According to court documents, Transurban allegedly pursued one plaintiff for $9,440.90 for 10 purported toll violations totaling approximately $20. Another plaintiff, despite having a positive balance on his EZ Pass account, received summonses for $15,000 for toll violations totaling $30.65.

Private sector efficiency!

So that's life with tolls ("user fees").  Now, acquaint yourself with the term "milestone payment", as you may be hearing a lot of it in coming years:

User fees are not the only way to support public-private partnerships for infrastructure projects. Another model is called “availability payment” agreements, in which a private investor takes on most of the debt for a project up front and the public partner provides payments to the private partner during and after construction of the project.

In Florida, for example, the Port of Miami Tunnel was constructed through such a partnership. The private partner assumed most of the financial burden up front and the state agreed to pay off the debt in milestone payments over the next several decades. The tunnel opened in 2014 and was ahead of schedule.

But Randal O’Toole, senior fellow at the libertarian Cato Institute, said availability payment P3s can exacerbate a state’s debt problems while simultaneously hiding them.

“I think most availability payment systems are ways for [government agencies] to get around their debt limit,” O’Toole said. “If a private partner borrows a billion dollars … the debt doesn’t show up on the public agency’s ledger, so it doesn’t have to worry about exceeding its debt limit.

Which will Trump's P3 plan (assuming he sticks to his "deficit-neutral" guns) rely on more heavily: user fees (i.e., tolls) or milestone payments?  Probably a mix of both.  Either way, Pat Jones, CEO of the International Bridge, Tunnel and Turnpike Association (IBTTA), thinks that P3s won't cut it:

“You probably can’t satisfy all of [Trump’s $1 trillion plan] with private investment,” said Jones of the IBTTA. “I think it’s going to have to be a combination of private infrastructure spending and federal spending.”

This implies Trump and the GOP Congress will have to spend directly on infrastructure, i.e., socialism, if they want to stick to the $1 trillion infrastructure spend target.  Combined with massive tax cuts, this is highly unlikely to result in a deficit-neutral plan.  That doesn't bother me, but it should bother every "fiscal conservative" out there.

Lastly for now, as James Surowiecki points out, infrastructure program in this country tend to be victims of "mission creep," with actual costs far exceeding planned costs as scheming politicians hop on board, expanding planned projects far beyond their original scope.  And, of course, there's the "big, sexy project" factor - everyone wants one, even though the work that really needs to be done in this country is frequently far less glamorous:

A major cause of scope creep is the fact that infrastructure spending is at the mercy of political winds. Planners know that opportunities to build are limited, so when they do get a chance they tend to milk it for all it’s worth. Politicians, meanwhile, like big, splashy projects that will win headlines and capture the public’s attention. This is why we end up putting money into new projects while skimping on maintenance, even though the return on investment from simply keeping roads and bridges in good shape is usually higher.


Conservatives often reflexively dismiss infrastructure spending as a boondoggle, and liberals, perhaps in reaction, often reflexively defend it, no matter how wasteful. But the pool of dollars available for something like public transit is limited. The result of extravagant spending on subways and the like is that we end up with fewer of them than other cities. For the price of what New York spent on Calatrava’s PATH station alone, Stockholm is building nineteen kilometres of subway track and a six-kilometre commuter-rail tunnel. Worse, cost overruns fuel public skepticism toward government, making it harder to invest the next time around. It’s good for government to do big things, great things. But it’s better if it can do them under budget.

Boy! Long post today.  In case you're skimming all the way to the end, I'll try to sum it all up here:
  • The market is stoked for Trump's infrastructure plan; the Fed isn't necessarily buying it.
  • Trump's plan might be far smaller than anticipated.
  • Trump's plan might take years to put into effect.
  • Trump's plan might be subject to considerable cost overruns.
  • Any economic boom from Trump's plan might be offset by the stronger dollar.
  • There's just a tremendous amount of uncertainty, period.
I suspect for most people, the bottom line is jobs.  All the problems in the world will be irrelevant if we're all earning a good income.  In 2020, will we all be better off than we were four years ago? 

I certainly hope we will.  But there are a lot of very good reasons to be skeptical.  

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